Saying that marijuana stocks have struggled this year would be a huge understatement. Investor sentiment toward marijuana stocks has shifted dramatically from one of eternal bliss and optimism to one of increasing fear and skepticism. This is typical of bubbles.
The question now is whether there is an even bigger marijuana share crash coming or whether pot stocks will pull themselves together and at least stabilize. Let’s take a look at this question, with a focus on the once favourite marijuana stock, Canopy Growth Corp. (TSX:WEED)(NYSE:CGC).
Canopy Growth stock is down 26% year to date, and down a shocking 63% from 2018 highs, effectively erasing all gains that were made since 2017. So now that the froth is gone (maybe), we can perhaps start to look at these stocks rationally.
Profitability proves elusive for Canopy Growth
In fiscal 2019, the company’s net loss per share was $2.67, compared to the average of analyst estimates (the consensus estimate) earlier in the year that was calling for a net loss of $1.78 per share. At this point, the fiscal 2020 consensus earnings per share estimate is for a net loss of $4.33, an estimate that keeps getting revised dramatically lower after results keep disappointing.
Given that earnings continue to disappoint, that sequential revenue growth has been slowing (13.2% in the fourth quarter of fiscal 2019), and that gross margins are falling sharply, the road to profitability for Canopy Growth looks like it will be long and hard.
Canopy Growth stock has sharply negative earnings yet it is still trading at a price to sales multiple of 32 times. Despite the great potential of the marijuana industry and the explosive potential growth of companies like Canopy Growth, we cannot deny that this profile looks ominous.
Marijuana industry proves itself to be challenging
The marijuana industry is new and emerging, with many uncertainties and many stops and starts. Black market marijuana prices are reportedly still 30% to 35% lower than legal prices, and black market sales have proven to be sticky. Supply of legal marijuana has therefore been overshot and now this oversupply is a problem.
For its part, Canopy Growth continues to move ahead, recently announcing that approximately 30 pot-infused products will be on the market by the end of this year, including beverage, edible, and vape products. These products are expected to be higher margin products and they are expected to allow Canopy to reach new customers.
The growth plan remains focused first on building intellectual property, building brands, and international reach. Number two on the list of priorities is becoming high margin operators here in Canada as the growth phase comes to a close.
The lesson here, in my mind, is that with new, emerging industries we need to exercise caution. The cannabis industry today is rapidly emerging and promises to be a very lucrative one with many winners but also many losers. With so many companies vying for the top spots, it seems clear that not all of them will make it.
Foolish bottom line
At this point, Canopy Growth stock is still riding the downward momentum, and with big losses continuing to accumulate, profitability being pushed further out, and valuations that remain high, I would not be surprised to see another marijuana stock crash.
As far as adding Canopy Growth stock for exposure to the potential upside, I would favour adding a small basket of marijuana stocks to diversify and lower your risk in this risky space as investor capitulation is reached.
